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Accounting issues have forever been the bone of contention in the corporate world. Ever since a large accounting scandals ripped through the last decade, auditors are finding themselves at the receiving end of the profession.
It's an issue that has cost auditors a lot, and perhaps could even see an exodus of sorts from the auditing profession in the coming years. The new Companies Act has imposed severe penalties on auditors of companies so much so that it severely crimps the growth and flexibility of auditors and is also likely to dissuade new professionals from the joining the profession.
Penalties for auditors have gone up several fold. Investors can even initiate a class-action lawsuits against the auditors – the kind that is prevalent in the west. For negligence in their duties, an auditor is liable to pay damages to the company or any other person for losses arising from incorrect statements in the audit report. In case of a class-action lawsuit, will have to pay from their own pocket depending on the amount claimed by the litigants.
Auditors have to be compulsorily rotated at the end of two five-year terms as per the new rules updated yesterday. The five-year period for rotation in the case of an individual and ten-year period for a firm will be calculated retrospectively.
Auditors fear that the rotation policy will impact the smaller firms and they will be forced to consolidate as they will not be able to attract new talent for auditing. Says N Venkatram, managing partner, audit, Deloitte, Haskins & Sells: “The increased demands on the audit profession and the churn in audit clients that is mandated will cause hardship for a few years. The retrospective application of rotation rules would necessarily result in increased cost and hardship to both companies and clients, and have the unintended consequence of harming audit quality.”
The new rules have given some breather in terms of reporting on fraud by auditors to the Central Government. Auditors are required to report material fraud within 30 days to the government. Materiality shall mean frauds that are happening frequently or frauds where the amount involved or likely to be involved is not less than 5% of net profit or 2% of turnover of the company for the preceding financial year. Says Says Harinderjit Singh, partner, Price Waterhouse: “A mere allegation or suspicion will now have to be reported to the government. Professional guidance will need to be given to auditors.”
However, the new Company Act imposes severe penalties on auditors of companies for various issues such as non-filing of documents. It has also introduced the concept of class-action lawsuits. For negligence in their duties, an auditor is liable to pay damages to the company or any other person for losses arising from incorrect statements in the audit report.
Company auditors are clearly worried that this is going to impact the business of auditing for small and big firms. Says Shailesh Haribhakti, chairman, DH Consultants: “It’s going to be very difficult for the auditing profession to attract, retain and deploy new talent as the risks have gone up tremendously. Auditing will become more time consuming and the costs will go up.”
Auditors fear that the Act will also increase their workload considerably as they will have to go through a larger number of transactions for their and keep the extensive details on many transactions. Auditors also have to take indemnity insurance against third party liabilities, which is going to be highly expensive. Auditors fear that only the larger firms will be able to afford higher insurance costs.
The Act also mandates that the firm and all its partners are jointly liable for any fraudulent actions of even a single partner. Earlier only the partner in concern had to face the consequences of negligence, but with this new rule, an entire firm of auditors might have to down their shutters for the errors of one partner. Says Singh: “It was always the individual who was signing the accounts. Now with the concept of an entire firm being held responsible, the existence of the firm itself can be in jeopardy, without the relevant due process being defined.”
The auditor is now also required to report on whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls. Says Venkatram: “It is necessary that the rules clearly lay down the processes that need to be followed by the management of companies to make this evaluation. Based on the US experience, this is likely to be an onerous responsibility on both management and auditors which will be expensive to implement.”
A typical accountant goes through strenuous training in the first three years of his education at the same time undergoes examination that is very rigorous that only a small percentage manage to clear at first attempt. Its only after they clear theses tests that they can apply for membership of the Institute of Chartered Accountants of India and start or join an existing practice.
As if that's not enough, a new rotation policy restricts the number of years an auditor can remain as the auditor. Companies have to compulsorily change their auditors after a period of 10 years. Auditors fear that the rotation policy will impact the smaller firms as they will not have the bandwidth to take on complex jobs.
But the worse part is that the new auditors can re-state the accounts of the old auditors, if they are if they are not convinced the old accounts are authentic. A restating of accounts will bring its own set of problems as the earlier auditor will then be liable to litigations, penalties and long-winding explanations of the accounting standards that were used.
There are other apparent problems. A partner can now do only 20 audits per months, without any distinction between public and private companies. Auditors fear that this reduces the amount of work that they can take and increases their costs. It also does not take into account an auditor’s experience or capabilities within an audit firm to be able to take on more complex jobs.
Auditors are also prohibited from proving non-audit services such as consultancy including investment advisory, investment banking and management services. Auditors have for long have set up management information systems that aims to provide company management with crucial information on business growth. This will see the revenues of audit firms declining. Auditors are also restrained from providing such services to any other group firm, as this will altogether bar them from auditing any of the group firms.
But perhaps one of the biggest issues is that the auditors will now have to follow accounting laws issued by the National Financial Reporting Authority which will prescribe the standards to be followed. Auditors have been following the prescribed rules of the Institute of Chartered Accountants. Auditors are apprehensive that that now they will be accountable to two regulators and this is going to cause a big conflict of interest. The ICAI sets accounting standards and ensures that the members adhere to highest levels of professional practice.
While the auditors are apprehensive about the additional burden on them, shareholders could be rest assured that the quality of accounts could get better. Auditors will now make stringent and more disclosures about a company's accounting policies, and the auditors that are found negligent in their duties will be penalised. Auditors for their part say that they were anyways governed by the byelaws of the ICAI Act.
Auditors say the new Act has not been very kind of the profession. Auditors now fear that auditing will now become a high cost and a highly conservative in their business practices, and they are at the receiving end for problems not entirely of their doing. This once lofty profession is now at the risk of losing its shine.
